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Ilana Industries Inc. needs a new lathe. It can buy a new high-speed lathe for $1 million. The lathe will cost $36,000 per year to run, but it will save the firm $123,000 in labor costs and will be useful for 11 years. Suppose that for tax purposes, the lathe will be in an asset class with a CCA rate of 25%. Ilana has many other assets in this asset class. The lathe is expected to have an 11-year life with a salvage value of $115,000. The actual market value of the lathe at the same time will also be $115,000. The discount rate is 5%, and the corporate tax rate is 35%.

What is the NPV of buying the new lathe?

(A negative amount should be indicated by a minus sign. Enter your answer in dollars, not in millions. Do not round intermediate calculations. Round your answer to 2 decimal places.)

Answer :

The NPV of buying the new lathe is $317,007.98.To calculate the NPV (Net Present Value) of buying the new lathe, we need to consider the initial cost, annual savings, salvage value, and the discount rate.

1. Initial cost: The lathe costs $1 million.
2. Annual savings: The lathe will save the firm $123,000 in labor costs every year.
3. Salvage value: The lathe is expected to have a salvage value of $115,000 after 11 years.
4. Discount rate: The discount rate is 5%.

To calculate the NPV, we need to determine the present value of the annual savings and the salvage value. We can use the formula:

NPV = Present value of cash inflows - Present value of cash outflows

1. Present value of cash inflows:
The annual savings of $123,000 for 11 years can be discounted using the discount rate of 5%. Using the present value of an annuity formula, the present value of the annual savings is $985,533.79.

2. Present value of cash outflows:
The initial cost of $1 million can be discounted to its present value using the discount rate of 5%. The present value of the initial cost is $783,526.81.

3. Salvage value:
The salvage value of $115,000 after 11 years is the same as the market value. So there is no need to discount it.

Now, we can calculate the NPV:
NPV = $985,533.79 (present value of cash inflows) - $783,526.81 (present value of cash outflows) + $115,000 (salvage value)
NPV = $317,007.98

Therefore, the NPV of buying the new lathe is $317,007.98.

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